We've often talked about behavior being the key element in a successful investment experience. We are starting to see signs of this behavior manifest itself in questions from clients asking if they should lighten up their exposure to emerging market stocks or energy investments. Of course, these are areas of the market that have been hit the worst over the past several years. It has been shown through countless studies that humans hate losses more than they love gains. It has been hardwired into our DNA for thousands of years. Fear kept us alive when we were living in the wild, dealing with life threatening risks on a daily basis. Our fight or flight reaction has been finely tuned to allow our species to survive and thrive throughout human existence. Unfortunately, those emotional responses that have been so beneficial over time are destroying our investment returns.
When our investments fall, we get scared and our instincts tell us that something is wrong. This is the way our brain has worked throughout time. But what if we didn't get scared? It was always more theory that our emotional response was hurting our returns, but 10 years ago an interesting study was done. Here is the gist (from the WSJ):
How many investors take an approach like the non brain-damaged investor? After they've lost money, they are less apt to play anymore. I still come across investors who sold out of their investments in 2008 and never got back in. Fear of loss is powerful. It can make us behave irrationally. How do we overcome this instinctive tendency? First, before making any investment decisions, it is important to understand how you are feeling at that moment. Am I scared? Is this a logical decision? Second, automate it. Using a simple asset allocation strategy like a target date fund inside a 401k plan or an advisor managed model portfolio, allows us to make less decisions. This is almost always a good thing. Finally, and most importantly, get outside counsel. Whether you work with a trusted advisor or just have someone you trust to go to when you are planning on making a change, it is important to find someone who will tell you what they are thinking. Someone who doesn't have an emotional tie to your money but still is acting in your best interest. Those investors who can not only recognize their emotional biases but also act against them (buying after a major drop in the market) will find tremendous success in the future.
Information contained herein has been obtained from sources considered reliable, but its accuracy and completeness are not guaranteed. It is not intended as the primary basis for financial planning or investment decisions and should not be construed as advice meeting the particular investment needs of any investor. This material has been prepared for information purposes only and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Past performance is no guarantee of future results.